China Joins Hands with Major SWFs to Set Ground Rules

By Lin Li, Zuo Maohong
Published: 2008-09-05

The International Monetary Fund (IMF) has brokered a voluntary code of conduct for sovereign wealth funds (SWFs), yet its nature and the main actors behind it have raised doubts.

The draft code, known as Generally Accepted Principles and Practices for Sovereign Wealth Funds (GAPP), was deliberated by SWFs from 26 nations (see list below) at a meeting held in Santiago, Chile, on Sept 1 and 2, thus also known as the "Santiago Principles".

The 26 members of the International Working Group of SWFs (IWG-SWF) - formed earlier this year to facilitate dialog and establish a guide on governance and investment practices for state-owned funds - would finalize the draft on October 11 when it meets again in Washington DC. No specific details would be disclosed prior to that.

The IWG-SWF was co-chaired by a director of the Abu Dhabi Investment Authority (ADIA), the credentials of which could raise doubts, said Carl Linaburg, vice-president of US-based SWF Institute, an impartial organization dedicated to the study of SWF's impact on global economics and politics.

"ADIA ranks quite low in transparency relative to them having the highest sovereign assets under management, so a lot of people may question the effectiveness of these guidelines," said Linaburg in an email interview with the EO.

Old in Existence; New in Suspicion
Though born in the 1950s, nearly two thirds of the existing SWFs in 38 countries today were established in the past decade. As state-backed giants, these funds roused suspicions of politically-motivated investments when they acquired strategic businesses and iconic companies in foreign countries.

According to market estimates, SWFs today managed assets worth between two and three trillion dollars, a value that was projected to exceed global foreign exchange reserves in the near future. The latter were estimated to reach between seven and eleven trillion dollars by 2013.

Some of the largest funds originated from oil-rich countries like Middle East nations and Russia, and big Asian exporters like China. Some countries on the receiving-end of their investments like the US and Germany have expressed unease, often citing transparency of these funds as a main concern.

Germany for instance moved a bill last month to block acquisition of more than 25% stake in German firms by foreign entities, namely petrodollar-rich SWFs not based in the EU, citing reasons such as safeguarding national security.

IMF first deputy managing director John Lipsky, in a speech delivered to a seminar in Chile on Sept 3, sought to ease concerns by saying transparency was an important condition for the success of SWFs, including regular disclosure of their funding, investment objectives, asset size and allocation.

The co-chair of the IWG-SWF, Hamad al Suwaidi, of ADIA, said that the GAPP "will promote a clearer understanding of the institutional framework, governance, and investment operations of SWFs, thereby fostering trust and confidence in the international financial system".

However, Brussles-based think tank Bruegel's research fellow Nicolas Véron said the voluntary approach remained a relatively weak incentive, and he would not expect it to materially change the behavior of these funds in the short term.

"It certainly won't put an end to the debate about openness to foreign investment, either in developed countries or in developing ones," he told the EO via email.

China's Participation
The 200-billion-dollar-strong China Investment Corporation (CIC), one of the youngest SWFs set up in September 2007, had been under intense global scrutiny since it began its preparation to launch. It too was participating in the Chile meet for the GAPP draft.

China's participation was a reversal in behavior, as it did not join earlier dialogs between the ADIA, Singapore's Government Investment Corporation (GIC) and the US Treasury on SWF guiding principles, said researcher Zhang Ming, of the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, a major think tank for the Chinese government.

He said CIC's participation in the drafting signified that it had realized the importance of having a say in the making of rules and codes governing the international financial system, and made conscious efforts to influence the outcome.

"To the developed nations, they are guarding against emerging and petrodollar-rich countries, and hope to restrain the latter to protect their own national interests.

"And for the SWFs under suspicion, in knowing that there existed efforts to limit their development through rules and codes, the best counter-measure is to become a participant in the process of rules drafting. That explained why more and more SWFs joined the IWG-SWF," he told the EO.

Zhang said that when the participating membership enlarged, the consensus reached would have been a compromise as various parties contested for interests and influence, adding that he believed the GAPP would be lacking in forceful and specific terms.

"It will most likely have general clauses on the need for information disclosure, strengthen funds management, and so on. Its short term impact will be limited. But if all members are voluntarily binding to the code, it could create peer pressure," he said.

Zhang believed a more urgent issue about SWF that the Chinese government should consider now concerned "domestic" coordination.

Though CIC had attracted most of the global scrutiny, Chinese government investments were made through various entities like the State Administration of Foreign Exchange (SAFE), the China Development Bank, and the National Social Security Fund, just to name a few.

Zhang said there were some rivalries between these entities, and the government should coordinate their overseas investment behavior and map out a holistic strategy to ensure they "cooperate while competing".

The list of 26 members of the IWG-SWF:
Australia, Azerbaijan, Bahrain, Botswana, Canada, Chile, China, Equatorial Guinea, Iran, Ireland, South Korea, Kuwait, Libya, Mexico, New Zealand, Norway, Qatar, Russia, Singapore, Timor-Leste, Trinidad & Tobago, the United Arab Emirates, and the United States. Oman, Saudi Arabia, Vietnam, the OECD, and the World Bank, participate as permanent observers.